Econ-Atrocity: Bush’s fundamental error: Social Security is insurance, not a pension

(Part one of two)
By Professor Gerald Friedman, University of Massachusetts at Amherst

President Bush is fundamentally wrong about Social Security. His proposal shows he thinks Social Security is a pension plan ““ a form of individual savings towards retirement. But Social Security is not a pension plan. It is a social insurance program: it provides benefits to individuals according to their situation, rather than strictly according to their contributions.

Social Security is insurance against some of the misfortunes that may afflict us: old age, disability, and death. The Social Security Act of 1935, which created Social Security, also created other social insurance programs ““ like unemployment insurance and Aid to Families with Dependent Children. Since then, programs have been established to encourage workplace pensions and private savings, like 401K plans and Individual Retirement Accounts. But Social Security has remained apart because it is not a savings or pension plan; it is a program where we all protect one another against the maladies and afflictions of life.

Seen as an insurance program, Social Security should be evaluated according to different criteria than one would use to evaluate a pension plan. Some economists and administration officials have criticized Social Security because of the low rate of return some retirees receive for their lifetime contributions. By the same logic, they might criticize my homeowner’s insurance plan because after 16 years, I have paid over $8,000 into it without receiving any benefits. Have I wasted my money on a bad investment? No ““ because it’s not an investment, it’s an insurance plan.

The same holds for Social Security. Unlike pensions or savings plans where individuals look to maximize their expected returns, we look for something different from insurance: adequacy and protection. We ask: will the insurance we have provide enough coverage? Will it be there when we need it? And does it come at an excessive premium?
Judged by these criteria, Social Security has been a great success. Consider:

* Social Security protects the elderly from the risk of outliving their means. Unlike savings or many pensions, the elderly cannot outlive their Social Security. Social Security accounts for 40% of the income of the elderly, and the proportion rises with age. Over 90% of elderly Americans receive Social Security benefits; by contrast, only 42% receive pensions and 67% receive investment income.

* Social Security lifts millions of older Americans out of poverty. Unlike pension benefits that depend on past contributions and earnings, Social Security benefits are progressive to favor the poor. For the lowest wage workers, benefits replace 70% of wage income, and for nearly a third of these, Social Security accounts for over 90% of income after retirement. For the highest wage workers, benefits replace just 23% of wage income. Without Social Security, 48% of people over age 65 would be in poverty; Social Security reduces that figure to barely 8%.

* A majority of Social Security recipients are women. Because women live longer than men, have generally earned less than men, and are less likely to have a pension, they are more vulnerable to exhausting their savings ““ so they depend more on Social Security than do men. Women also benefit from Social Security’s survivor benefits and provisions giving home-makers benefits equal to half the benefits provided to spouses who worked outside the home.

* Social Security also provides disability benefits to over 5 million people, including children and spouses of disabled people. In addition, Social Security provides benefits to 11 million children, spouses, and widows of retired workers. Fewer than two-thirds of recipients are retired workers.

* All of this coverage is provided at very low cost. Because Social Security is a universal system, it operates with extremely low administrative costs. Only 0.7% of the program’s income goes to administrative costs ““ half the level of the best mutual funds and a small fraction the rate of private insurance. This leaves more money for benefits.

There are problems with Social Security. Too many workers, especially low wage workers in agriculture and domestic service, are not covered. The disability benefit program has sometimes been too slow in providing benefits, and too restrictive in the categories of disabilities covered. Medical benefits, administered in the separate Medicare program, need to be adequately funded and extended to long-term health care. All of these problems require that this successful program be expanded. There is no justification for abandoning what works.

President Bush objects that he and his wealthy supporters get a bad deal from Social Security. They do: for the affluent, a program that pays more to low wage workers is a bad investment ““ at least if all you consider is the personal return. President Bush and his friends would destroy Social Security because they do not need it. But the rest of us do.

Next: Is there a retirement crisis?

Sources:

Dean Baker and Mark Weisbrot, Social Security: The Phony Crisis (Chicago, 1999).

Peter A. Diamond and Peter R. Orszag, Saving Social Security: A Balanced Approach (Washington, D.C., 2004).

Economic Policy Institute, “Issue Guide: Social Security

Social Security Administration, Income of the Aged Chartbook 2000 (Washington, D.C., 2002).

(c) 2005 Center for Popular Economics

Econ-Atrocities are a periodic publication of the Center for Popular Economics. They are the work of their authors and reflect their author’s opinions and analyses. CPE does not necessarily endorse any particular idea expressed in these articles.